China’s Credit Squeeze

CHINA’s leaders have so far refused to back down from their efforts to deal with excessive lending growth, despite a growing credit crisis.

Yesterday, the central bank rebuffed pleas to inject more cash into the financial system, adding to the problems of overstretched lenders, the Financial Times wrote in this article.

“Short-term money market rates surged to all-time highs. The seven-day bond repurchase rate, a key gauge of liquidity in China, jumped 270 basis points to 10.8%, nearly triple where it stood just two weeks ago,” continued the FT.

“Interbank lending rates were also pushed higher and the pain spread to the stock market. The Shanghai Composite Index, the country’s main stock index, fell 1.4% in the morning trading session, also pressured by the news that the US Federal Reserve may start to unwind its monetary policy easing later this year.”

The credit squeeze worsened on the same day that the June HSBC/Markit flash purchasing managers’ index (PMI) for June was released. The PMI fell to 48.3, a nine-month low from 49.2 in May. Production and new business orders also declined (see the above charts).

But we still believe that Beijing will stick to its guns. It cannot afford a further increase in bad debts, and more investment in more unneeded infrastructure and industrial capacity, and so we think that the liquidity drain will continue.

This is sure to further dampen GDP growth, which will, of course, have a negative impact on petrochemicals markets.

More immediately, we think there is a risk that polyolefins traders have built stocks over the last few weeks on the assumption that China would ease lending conditions. These stocks could soon, therefore, unwind.